The main reason people are choosing to take this drastic step, in spite of having a good job with sufficient income to pay their mortgage, is that housing prices have fallen so far in some areas and may have little hope for recovery any time soon. People just can see continuing to invest money in an asset that no longer has the value they expected, even given the considerable negative effect strategic defaults have on a person’s credit score.

In the past, strategic defaults were rare. Generally, mortgage defaults were caused by a serious financial problem the borrower encountered, such as long term job loss or a medical crisis. Occasionally, there would be strategic defaults by people who had purchased a dangerously faulty home or who had another non-financial crisis but this was quite rare. In most cases, people were willing to tough out bad situations in order to save their home and credit. But, today, this may be changing.

Financial experts have long assumed that 99% of the time a homeowner would not chose to face the serious consequences of defaulting on a mortgage. They believed that borrowers would rather deal with problems associated with a home rather than having their credit ruined and never owning a home again. But, this attitude seems to be changing. Why?

In areas that have been hard hit by the housing crisis, such as California, home values have fallen an average of 45% from peak prices of 2005-2006. This would make a house that was worth $500,000 in 2006 worth about $275,000 in 2010. What’s worse, economists are predicting that home prices may not rise significantly for 10 to 12 years in certain hard hit areas. This economic climate makes strategic defaulting an attractive choice for many homeowners.

On paper, it makes sense to do a strategic default for people living in certain areas. Since home values are expected to remain low for so long, a homeowner could potentially lose thousands of dollars should the sell their home or simply lose the opportunity cost for thousands in mortgage payments. The classic argument against renting is that you’re thowing money away, but, when there’s not equity to be gained from owning real estate it makes this argument less compelling. With rents depressed as well, a strategic default could put $1000 or more a month in the former homeowner’s wallet, freeing them up to purchase things, pay off other debts or even save money.

Also, in the era of big bank bailouts and long distance commuter subdivisions there is less civic pride to serve as a psychological barrier to strategic defaults. People today tend to see mortgage lenders more as “Mr. Potter” than “George Bailey” and thus don’t feel bad about defaulting on a mortgage loan that they believe was taking advantage of them. Also, with people less connected to their neighbors, they’re less likely to feel badly about the consequences their strategic default might have on their neighbor’s home prices and the quality of their community in general.

The only barrier that remains is the tough financial punishment that defaulting on a home loan brings. The result is that the defaulting borrower won’t be able to borrow money for quite some time except at very high interest rates. With the consumer credit markets remaining tight, one who does a strategic default on a mortgage may find it impossible to get a loan at any reasonable interest rate.

What does it mean financially if you do strategically default?

Basically, it means that if you carry out a strategic default you’ll be living on a cash basis for many years to come. Any consumer products you want, you’ll pay cash for them. If you buy a car, you’ll have to pay cash for it. And you probably won’t be able to qualify for a home loan for at least 10 years, maybe longer depending on what happens in the credit markets.

The bottom line is that you’ll have to maintain a strict financial life after you default. This kind of frugal, disciplined, lifestyle may be difficult for someone who’s been on a credit binge for years. Operating your household on a strict cash basis doesn’t come naturally for many people but it is possible if you commit yourself to it. In fact, I recommend it even if you don’t plan to do a strategic default. You’ll find yourself in much better financial shape if you do.

Should you do a strategic default on your mortgage?

A lot of people are asking themselves this question since around 15 million homes have mortgages that are upside down and nearly 5 million mortgages are facing foreclosure or are behind 2 or more months. Some estimates calculate that about 1/4 of these troubled mortgages are held by someone who may be in or considering a strategic default.

Such a default isn’t easy. It requires some tough choices and tough lifestyle changes. It requires balancing your civic responsibility to your community against your own financial well-being. It means determining if your personal integrity means that you should keep your promise to the mortgage lender. It means preparing yourself and your family to shun credit and live on cash only. These are questions that you’ll need to consider before committing to a strategic default on a mortgage.

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First, the rising number of homes for sale puts a drag on home prices that will be difficult to overcome for some time. This creates a difficult environment if you need to sell your home, even as a short sale, or refinance a home loan since it keeps home prices low. Even if you live in an area that isn’t as badly impacted, your home value will suffer too. While some home ownership tracking agencies report a tapering off of new foreclosures in heavily hit areas the current inventory glut means that the recovery of home prices is going to be pushed out several years.

However, the news that foreclosures in areas where there was a significant price bubble and many sub-prime loans isn’t getting worse has to be weighed against the news that prime, mainstream, home loans are being affected at an increasing rate. Homeowners who had good credit and a once solid earnings history are now beginning to default in increasing numbers due to job loss and other such factors related to the recession.

On top of this news, banks and other mortgage loan companies are beginning to move faster on foreclosures. Last year, many were under political pressure from the Obama administration and Congress to hold off on foreclosures. Now, with the new financial reform law passed and Democrats set to lose some control in Washington after the 2010 elections, this pressure appears to be reduced. Also, bank loan analysts have had enough time to discover if a loan is worth salvaging under various foreclosure relief programs. This means that banks are more prone to enforce their foreclosure rights now than they were a few months ago. The net effect is that strategic defaults and other delaying tactics which allowed people to stay in their homes for months or even a year or more without making a payment aren’t going to work now.

Unfortunately, all of this new foreclosure activity has caused an increase in the number of foreclosure relief scams. Be wary of anyone trying to sell you a program that encourages you to use dodgy techniques to forestall foreclosure. Banks have become wise to these tricks and are moving ahead with foreclosure if they think a home loan can’t be saved.

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